The process of reshaping and refocusing
PepsiCo, which commenced in 1996, is expected to leave the US-based soft drinks and snacks
giant in a stronger position as it enters the new millennium than it has been for many
years. By Mike Rohan.

PepsiCo’s ambitious ‘Project
Blue’ campaign signified the company’s last big play to try and catch up with
arch rival Coca-Cola in global soft drinks. Having since accepted that Coca-Cola is
unassailable in certain markets, PepsiCo has settled for making the most of being the
world’s second biggest soft drinks group and is now concentrating its efforts only on
those markets where it has the economies of scale and market share to compete effectively
with its US rival. This has meant retreating or scaling back in certain international soft
drinks markets – South Africa being a prime example where PepsiCo threw in the towel just
three years after re-entering the market in 1994.

In addition to a change in strategic
direction in soft drinks, PepsiCo has stepped up activity in snacks, where it is the
world’s leading player by far.

The reshaping of PepsiCo has involved refocusing and a radical restructuring of the
business, while simultaneously putting the group on a stronger financial footing to
achieve sustained long term growth. To achieve a sharper focus on soft drinks and snacks,
PepsiCo has divested non core businesses such as restaurants and a number of food
processing companies. The disengagement from restaurants, which involved spinning off
brands such as Pizza Hut, Taco Bell and Kentucky Fried Chicken, was completed in 1997 and
raised $5.5 billion.

The proceeds from the sales have been
reinvested in strengthening the remaining PepsiCo business centred on snacks – Frito Lay –
and soft drinks – Pepsi-Cola – and the recently acquired Tropicana. “These days you
can only succeed if you concentrate on what you do best and use your resources to their
greatest advantage,” reasons Roger Enrico, chairman and chief executive officer of

The ailing international soft drinks
business – Pepsi-Cola International – has been restructured, involving a charge of over
$500 million in 1996, in order to stem mounting losses, which soared to $846 million in
1996. The change in direction is starting to pay off with international soft drinks
volumes up 6% in 1998, the best performance in three years, and for the first time in its
history, the group sold more Pepsi in international markets than in the US. Pepsi-Cola has
also improved its performance in the US where last year it achieved its biggest market
share gain in nine years, as it increased volume by 6% – its best performance in four

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By GlobalData

Developing Snacks
Snacks, however, offer probably the brightest prospects for long-term growth. Since United
Biscuits abandoned its global aspirations and decided to retrench in certain markets,
Frito-Lay is clearly the world leader with a 35% share of the $36 billion global snack
chip market, and control of 60% of the massive $13 billion US market. Indeed, last
year’s acquisitions of United Biscuits’ snack operations in Australia and
northern Europe significantly strengthened Frito-Lay’s standing in these regions.

The strategy is to continue to broaden the
geographical base and increase penetration in existing markets. “Frito-Lay
International represents one of our biggest opportunities for rapid growth on a
large-scale,” says Roger Enrico. “We are the world’s largest salty snack
company. While we have our share of local competitors we face no major multinational
competition. Not only that, relatively low per-capita snack consumption in many countries
gives us tremendous room to grow. To exploit that opportunity fully, we need to build
greater scale.”

Although Frito-Lay is the market leader in
over half of the 42 countries in which it operates, the vast majority of its international
sales and profits are generated in just three markets – Mexico, the UK and Brazil. In most
other countries, Frito-Lay lacks the size to realise true economies of scale and the
associated higher profit margins. He continues: “One of our strategic goals has been
to enlarge those smaller operations, in part through acquisitions, so they can become more
important profit contributors. Not only will that improve our profit overall, it will make
us less dependent on a few key markets. That’s important when your goal is
consistency.” For example, the acquisition of Smith’s Snackfoods from United
Biscuits for $270 million last year allowed Frito-Lay to jump from number two to become
market leader in Australia. A combination of acquisitions and joint ventures has also
allowed Frito-Lay to build its market share in South and Central America to over 50%.

Separating the Bottling Business
A crucial element in the transformation has been PepsiCo’s decision to follow the
example of Coca-Cola and separate the bottling operation from the soft drinks concentrate
side of the business, leaving it free to focus on marketing and brand building. PepsiCo
has retained a 40% stake in Pepsi Bottling Group, which was demerged earlier this year.
Pepsi Bottling Group had sales of $7 billion last year but restructuring charges of $222
million left it $146 million in the red, compared with net income of $59m in the previous

The spin off of the bottling business has
left a radically different looking PepsiCo. The streamlined soft drinks operation
(Pepsi-Cola minus the bottling operating) now contributes just 30% of group operating
profits, leaving Frito- Lay snacks as the dominant part of PepsiCo.

Freed from the burden of operating a highly
capital intensive but low margin bottling business, PepsiCo is in a much stronger
financial position and also has proceeds of $5.8 billion from the sale of 60% of Pepsi
Bottling Group and from the merging of franchises with the Whitman Corporation, to invest
in acquisitions, especially for Frito- Lay, and share repurchases.

Acquisition of Tropicana
In addition to strengthening its soft drinks business through separating its bottling
operations, PepsiCo has also added Tropicana, the world’s largest branded juice
company which was acquired from Seagram for $3.3 billion in August 1998. Tropicana is a
good fit for PepsiCo’s existing soft drinks business. The acquisition broadens
Pepsi-Cola’s portfolio of international brands and also extends its reach into the
‘morning’ market, where consumption of traditional carbonated soft drinks is
relatively low. With orange juice featuring in only one in five US breakfasts, Tropicana
has plenty of room to grow, and the potential in Europe and other international markets is
even greater as per capita consumption is less than half of the US average.

Focus and Investment
PepsiCo’s strategy since 1996 has been all about ‘focus’ and
‘investment’. “Basically that means we’re focused on consumer packaged
goods businesses that play to our strengths – and we’re out of businesses that others
can do better,” explains Roger Enrico. “Most important, we’ve invested
billions of dollars in the heart and soul of our business: brands. We’ve been
expanding our distribution, creating innovative products and packages and adding powerful
new brands to our portfolio.” He continues: “The whole point is to make our
business much stronger and more competitive over the long term – and able to weather
economic storms and marketplace skirmishes with minimal disruption.”

Last year, PepsiCo increased income from
continuing operations by 34% to $1.99 billion on net sales up by 7% to $22.34 billion.
Progress has been continued in the first half of the current financial year. “Two
consecutive quarters of double-digit gains in segment operating profit are a clear sign
that PepsiCo today is strong and our strategy is on track. With a much sharper focus on
the marketplace we’re generating healthy volume gains, better returns and higher
earnings growth,” points out Roger Enrico.

Contrasting Fortunes
The strategic transformation of PepsiCo and its subsequent rise in fortunes is in sharp
contrast to its great rival Coca-Cola, which dogged by economic turmoil in key markets,
encountering problems with competition authorities and having been forced to recall
product in several countries, is currently experiencing one of the worst periods of its
illustrious history (see Panel).

By the start of the new millennium, PepsiCo
will have been fully transformed. “We’ll be a leaner, stronger company than a
few years ago and much better equipped to achieve the consistent earnings growth to which
we aspire,” he remarks. At this stage in its rehabilitation PepsiCo expects to have
more than 75% of its sales and profits generated in healthy, stable economies such as the
US, Canada and Europe, and to have a stronger balance sheet and the financial resources
and flexibility to repurchase shares and make strategic investments. PepsiCo is also
projecting double digit operating growth from continuing operations by the end of 1999 and
achieving a return on capital substantially higher than when the reshaping process

“In my view, PepsiCo is in the best
shape it’s been in years,” the PepsiCo chief concludes. “And I think that
we’re in a great position to pursue the vast opportunities ahead of us.”

Problems Mount at Coca-Cola
Having suffered the ignominy of a product recall in several European countries, Coca-Cola
now finds itself under investigation by the European Commission. The EC is examining
Coca-Cola’s sales practices in Austria, Germany and Denmark to see whether it is
abusing its dominant market position in those countries. The EC is also probing the
dealings of three of Coca-Cola’s bottling partners – London-based Coca-Cola
Beverages, Coca-Cola Nordic Beverages (controlled by Carlsberg) and Coca-Cola
Erfrischungsgetranke in Germany. Earlier this year, Coca-Cola ran into EC opposition over
its proposed acquisition of Cadbury Schweppes’ non-US bottling interests.

This deal, originally worth $1.85b, has
since been scaled back, with the exclusion of most of Cadbury Schweppes’ operations
in western Europe, and has now been completed with Coca-Cola acquiring Cadbury
Schweppes’ soft drinks businesses in 155 countries for $705m (£433m) cash. Further
payment is also due if the sale goes through in countries such as Canada, Mexico, New
Zealand and Australia, where regulators are still considering the implications.

The recent problems at Coca-Cola have been
compounded by the difficulties it was already experiencing last year when economic
turbulence in many of its overseas markets resulted in the group’s first annual fall
in earnings and revenue within living memory. After-tax profits declined 14% in 1998 to
$3.53b on revenues down by $55m to $18.8b. The company was also thwarted by the French
competition authority in its initial attempt to acquire Orangina from Pernod Ricard.

Brand Power – Top Global Food and
Drink Brands by Value

Source: Interbrand. Figures in brackets
indicate global ranking across all industrial sectors. Private companies such as Mars are
not included.